They also look like variance swaps for which the payment is based on the variance realized. I think the underlying idea is that the future ATM IV is a proxy for expected future volatility. However, ATM IV, Spot or Future, is not a good proxy for expected volatility when there is a significant correlation between the underlying and volatility. If volatility fell to 10% at the expiration of 12 months, the buyer would have to pay the seller an amount of 500 USD. This is different from the implied volatility used in options. At the beginning of the contract, the volatility strike is defined so that the net present value (NPA) the net present value (NPA) is the value of all future cash flows (positive and negative) over the life of an investment discounted to the present. NPV analysis is a form of intrinsic valuation and is widely used in the financial and accounting field to determine the value of a company, investment security, that the payment will be zero. In addition, no nominal amount is exchanged at the beginning of the contract. Imagine a situation where an institutional trader would like a volatility swap on an index like the S&P 500. The contract has a face value of $10,000 and a term of 12 months. Implied volatility is 15% depending on the investor`s prevailing sentiment. Therefore, the volatility strike for the contract is 15%. In twelve months, volatility will be 16%.
This is the volatility realized. There is a difference of 4%, or 40,000 $US ($1 million x 4%). The seller of the volatility swap pays $40,000 to the swap buyer, provided that the seller holds the leg firm and the buyer holds the floating leg. In structure, volatility swps look like variance sweatshirts, but variance swps are more often traded on stock markets. Since volatility swaps are over-the-counter (OTC) derivatives, trading in securities between two counterparties, executed outside formal stock markets and without prudential supervision, is over-the-counter (OTC). OTC trading is done in over-the-counter markets (a decentralized place without a physical location) through networks of traders, there are several ways to build them. The most common examples are the calculation of the volatility difference on a daily basis and not at the end of the contract, as well as the calculation of volatility differences on an annual basis. Volatility swap refers to a financial derivative whose payout is based on the volatility of the underlying asset of that security, which is a futures contractA futures contract, often reduced to « forward », is an agreement to buy or sell an asset at a certain price at a given time.
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